Open for business? Maybe

Open for business? Maybe

It sounds almost too good to be true. The Chinese retail market of 1.2 billion up-and-coming consumers, long the object of every international company's most-ardent desires, will become fully open to foreign retail distributors under a new Chinese law that will take effect next Jan. 1. This could open up a huge new market for the global logistics providers that support the retail industry.

The new law will allow foreign companies of any size to apply to Chinese authorities to set up their own networks for distributing to Chinese retail stores or to open their own retail stores. Until now, only large foreign companies with more than $2 billion in average annual sales were allowed to apply to set up in China. Companies with less than $2 billion in sales have been required to set up distribution networks through joint ventures with Chinese partners or through Chinese state-owned distributors or other intermediaries - requirements that have made it very expensive to distribute in China.

But foreign retail distributors will probably not be able to kick back with a cold Tsingtao anytime soon. Freedom to apply is one thing; approval is another. They are almost sure to encounter bureaucratic hurdles that the new law cannot remove overnight. Even after those obstacles are cleared, they will still face enormous problems with China's woefully antiquated logistics infrastructure. "Just because the law changes doesn't mean China changes," said Jon Monroe, a Sausalito, Calif., consultant specializing in China sourcing and distribution. "The reality of the market has not changed just because the regulations are now in black and white."

Currently, foreign consumer product companies are restricted from distributing imported products and from managing distribution networks or wholesaling outlets and warehouses. These restrictions are designed to protect China's domestic distribution companies, which developed from state-owned distribution centers or are part of the private distribution companies set up after China permitted private enterprise in this sector.

In theory, the new law ends those restrictions as part of the conditions China agreed to to gain membership into the World Trade Organization in November 2001. It pushes down to local provincial authorities the approval of foreign companies' applications to set up their own distribution network or their own stores. While this may shorten the time it takes to get a decision, it may also bring its own set of problems, said Bill Primosch, director of international business policy at the National Association of Manufacturers, which is closely monitoring implementation of the law. "There are a variety of barriers to both importers and foreign-owned producers," he said. "What we're finding is that when one barrier comes down, others spring up."

Primosch worries that provincial authorities may erect barriers to protect local manufacturers, distributors or retail stores. "The provincial authorities frequently impose regulations and requirements that are designed to prevent companies from outside the area from competing with local companies," he said. That's why the NAM plans to watch to see whether Beijing will provide the oversight necessary to ensure that local authorities comply with it.

Beijing, however, may not be able to enforce the implementation of the law in all of the 32 provinces that make up China. "Outside of Beijing, the provinces are a law unto themselves," said Peter Huels, managing director of BDP Asia Pacific, a subsidiary of BDP International, the Philadelphia-based logistics and transportation services company. But that doesn't mean that global retailers won't try to set up distribution in China. The lure of the market is too great to ignore, he said. As soon as the retailers among his customer base move into China, he plans to expand the BDP network of offices in China, hire more employees and invest in more information technology. "We have to follow our customers," he said. "They will need us to support their distribution networks."

Monroe is not as worried about the difficulty of bargaining for approval of distribution with local authorities. "All of the local governments are being much more supportive of foreign investment," he said. Monroe said local governments tend to be very sophisticated in attracting foreign investment, although this can vary from province to province. He cited the government of Chongqing, which has 30 million people, as among the most sophisticated. "They want foreign capital to spur economic activity. There is construction going on 24/7, all done to support logistics and distribution." But he added, "The fact is that you can be too early unless the state-owned enterprises (SOEs) responsible for logistics activities change the way they are structured."

This is especially true of the retail sector. "The retail sector is what we call deep integration into a country's economy," said Jeffrey A. Frankel, the James W. Harper professor of capital formation and growth at the Kennedy School of Government at Harvard University. "That's why we bargained pretty hard to get China to open up its retail sector and allow our companies to open outlets in China," said Frankel, who was a member of President Clinton's Council of Economic Advisers at the time of the WTO negotiations with China in 1999.

Ordinarily, developing countries that sign trade agreements with the U.S. are not required to open up their retail sectors to foreign investment and distribution, Frankel said. Even in the case of Japan, a developed country, it took the U.S. more than 30 years to get it to open its retail sector to foreign investment. "But we had to build a strong case for signing an agreement with China, because there was a lot of opposition in the Senate to doing business in China without their opening up the retail sector."

The ability of foreign retail distributors to enter China without a local joint-venture partner or cut out any other distribution intermediary is likely to result in big savings. As of now, most of China's retail distribution is still in the hands of Chinese state-owned enterprises and suffer from all of their ills. The state-owned distributors send a product to the provincial distributors, which in turn sell to retailers. In rural areas, where more geographic area has to be covered, the number of layers increases. This makes distribution easier and coverage of the retail territory possible because distributors pool and distribute their products over larger territories. But from the foreign supplier's point of view, every layer represents additional cost in the form of a 5 to 7 percent dealer's commission.

For these reasons foreign retail distributors that want to tap the China market are certain to persist in their efforts to get around any new barriers that spring up after the new retail distribution law takes effect, but it won't be easy to get around the existing state-owned distribution network.

"The potential for logistics sounds great, but the fact is that a lot of logistics activity is controlled by large SOEs, and they have not decided whether to outsource or not. If you are a 3PL and you are looking at providing outsourcing of logistics to SOEs, it's going to take a long time," Monroe said. "Even if the market starts to open up, it's got to open up in the SOEs. Regardless of the new regulations, there are other hurdles to outsourced logistics."

These hurdles include the difficulty of negotiating a deal with SOEs. For example, he said, "Putting a price on the value of an asset you are buying is very difficult. If you want to build a warehouse from scratch, or buy one, the problem is valuing the land. It's been an arduous process for us."

Another hurdle is that China's logistics infrastructure is still very much a work in progress. "The infrastructure is not there," Monroe said. But it is being developed so rapidly that spending on logistics in China as a percentage of gross domestic product is approximately twice the 8.5 percent figure in the U.S., he explained. One illustration of the difference is that the density of land transport systems in China works out at just 98 miles of road or rail for every 621 square miles of land, compared with 447 miles per 621 square miles in the U.S. and 1,950 miles per 621 square miles in Japan. The U.K. lies somewhere in the middle, with 1,999 miles of road or rail per 621 square miles of land.

Drewry Shipping Consultants of London calls China's distribution systems "outdated and inflexible," with the result that moving goods to or from the factory or port to a warehouse or retail outlet is "slow, inefficient (with a relatively high incidence of damage and loss occurring) and, above all, expensive."

In a 2003 report entitled China's Transport Infrastructure and Logistics, Drewry said inventory levels have to be maintained at much higher levels be-cause turnover times are extended. The problems are partly related to the lack of infrastructure, which continues to struggle to catch up with soaring demand. Despite considerable investment, China's economic growth has been so rapid that its systems and infrastructure seem forever being stretched.